Structured Credit Market Views Volume 1

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2018 was a year of contrasts for the European structured credit and leveraged loan markets. While the start of the year was characterised by tight spreads and very strong issuance in both the CLO and loan markets, volatility and widening spreads became increasingly prevalent towards the end of the year. The well-publicised sell-off in global equities at the end of 2018 was also experienced by wider financial markets, including the European credit markets. The European secondary high yield market was the first to see the impact, shortly followed by the leveraged loan market. The S&P European Leveraged Loan Index (ELLI) dropped from a high of 99.2 in October to 97.3 by 31 December, but loan prices quickly recovered at the start of 2019.

The last deal to be issued in the primary market in 2018 was a €114m term loan for Vue, the UK-based cinema group, which priced at a margin of 525bps. These deals brought the total leveraged loan 2018 new issuance volume to close to €81bn, a c. €3bn+ increase from 2017. This was a modest increase compared to the bumper year that European CLO issuance had, rising by 30% to €27bn by the end of 2018. This was achieved despite increasingly challenging market conditions in the final two months of the year, with CLO liabilities widening considerably and quarterly institutional loan volume shrinking to its lowest level since 2015.

Moving onto 2019, 6 out of the 8 primary CLO deals priced in Europe YTD have had their AAAs taken by a Japanese anchor, pricing at 108bps. This is a meaningful widening versus the last print of 2018 where Partners Group priced their floating AAA tranche at 102bps. These deals are pricing in a backdrop of perhaps more than 30 open CLO warehouses, and at least 10 with more than €150m of assets. In contrast, Spire and ICG both priced their AAAs at 114bps, the only managers to price a deal this year where the AAAs have not had a Japanese anchor. If we look at the end of 2018 as a reference point, the basis between an anchored and a widely syndicated AAA deal was close to zero, hence one may expect this basis to come in. Whether it will be the Japanese investors printing wider or the syndicated AAAs pricing tighter, that is to be seen, though it is likely that the Japanese anchor bid goes wider in the short term.

In the middle of the liability stack, we are starting to see a much needed manager tiering appearing in Europe, something that was much less evident last year. On BB rated note tranches issued in primary, we believe there was a 90bps basis between the tightest and widest new issue print this year.

Given the backdrop on liability spreads, the arbitrage is clearly challenging today, especially for managers looking to price deals where they have more than 45% of their portfolios ramped at a spread lower than 400bps. Equity investors need to believe that asset spreads are going to widen from here when they underwrite these deals. If we look at leverage loan issuance, the start of the year has been slow. There were four add-on transactions in the market at the beginning of the year, all of which were well over-subscribed. The add-on to Nets, the Danish payments business, was rumoured to be over 6x subscribed, pricing at E+375bps. In addition, four new deals were issued, all of which priced at E+400bps, at the tighter end of price talk. There are now a few deals in the pipeline talked at E+400bps+ which is much needed, but there may be questions around the quality of some of the deals to come to market.

We look back at 1Q16, where the AAAs for new issue European CLOs priced between 145-150bps and European institutional loan spreads were E+480-500bp. In contrast, by 4Q16, loan spreads were at E+370-380bps. So for equity investors, in an environment where asset spreads do not widen considerably, it is a choice between primary where it may need a leap of faith that their chosen manager is able to trade their portfolios and add value through par build, or secondary equity where supply is picking up, be it only very slowly, but there is a lot more credit work that needs to be done for those underperforming credits.

This update does not constitute an offer or invitation to purchase securities. No reliance shall be placed on any views or opinions contained herein. The market information contained in this update has been obtained from the following non-exhaustive list of sources: S&P LCD, Bloomberg